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April 11, 2013

DoubleLine’s Gundlach Crushes Notion of Great Rotation, Bond Bubble

The Great Rotation is ‘utterly illogical,’ DoubleLine CEO tells a full house at the New York Yacht Club

DoubleLine CEO Jeffrey Gundlach has a new twist on the thinking about the supposed “Great Rotation” from bonds to stocks that market watchers have been warning about this year, and it goes something like this: Great Rotation? Don’t be ridiculous—and we’re not in a bond bubble, either.

“The Great Rotation is a ridiculous notion. It’s utterly illogical,” Gundlach (left) told a full house on Thursday at the New York Yacht Club in Midtown Manhattan. “You could also call it a Great Rotation into bonds from stocks.”

In other words, Gundlach’s understanding of the movement of money between the equities and bond markets incorporates a broad spectrum of diversifiers outside of traditional fixed income and domestic equities. He sees money and opportunities flowing in and out of many asset classes—which explains why he also doesn’t believe in the so-called “bond bubble,” either.

Of course, this is coming from a well-known bond guru who made news last month when he announced that he had bought more long-term Treasuries in the last month than he had in the last four years. Gundlach’s purchase of a pile of benchmark 10-year Treasuries happened when yields rose briefly above 2% in late January and early February.

‘Who Has Money in a Treasury Bond Fund?’

But he didn’t advise his Yacht Club audience of investors, brokers and journalists to buy Treasuries. Gundlach asked for a show of hands in response to the question, “Who here in this room has money in a Treasury bond fund?” No one raised a hand, and Gundlach wasn’t surprised, saying that the U.S. Treasury clearly doesn’t want any customers outside of central banks and active traders like himself.

Gundlach also discouraged investors from index funds pegged to the Barclays U.S. Aggregate Bond Index, saying “very few people are going to want to own this thing” when they see 12-month trailing returns. The index, which tracks the broader debt market the way the S&P 500 tracks the stock market, declined 0.12% in the first quarter, largely because U.S. Treasuries and government-backed mortgage debt have gained a larger share of the index, according to a Wall Street Journal story published April 2.

The Federal Reserve and its chairman, Ben Bernanke, are quite aware of the consequences of their program of quantitative easing, but as out of control as QE seems, they see no observable negative consequences, so they will keep on buying up government and agency debt for years to come, Gundlach said.

(Sophie Gilbert, director of capital market insights at Russell Investments, also doesn’t believe in a bond bubble. The term "bubble" suggests that there will be a steep drop in prices of 15% to 20%, Gilbert said in a recent analyst note. “For bonds as measured by the Barclays U.S. Aggregate Bond Index to drop so significantly, interest rates would have to rise by about 5%. This would effectively be a rise of the 10-year U.S. Treasury yield to 7%, a highly unlikely scenario given that the Fed has announced its plans to keep interest rates low with continued QE policies until mid-2015,” she wrote.)

Opportunity Outside the U.S.

Meanwhile, Japan has initiated a giant quantitative easing program of its own that puts U.S. QE to shame, Gundlach said. The U.S. program would have to pay out $250 billion a month to match Japan—which is the sort of level that monetary dove New York Times columnist Paul Krugman keeps pushing for, Gundlach noted, adding that he’s keen to see the results of Japan’s QE experiment.

So with the developed world continuing down the path of QE and sub-3% yields, what does Gundlach like these days in the fixed-income markets? Non-traditional picks: global high-yield corporate debt, which yields 6.64% as of Dec. 31, according to Bank of America-Merrill Lynch index data; bank loans, yielding 6.26%, nonagency residential mortgage-backed securities, yielding 6.00%, and emerging-markets corporate and sovereign debt, both yielding above 4%.